The Center of the Universe

[Skip to the end]

The ‘demand destruction’ still leaves a net increase in demand, just smaller than anticipated.

While the US is using a tad less gasoline, consumption elsewhere has picked up.

And this is with a weak world economy:

NYMEX-Oil steadies on OPEC output cut

by Rebekah Kebede

Meanwhile, the International Energy Agency lowered its 2008 world oil demand growth forecast by 100,000 barrels per day (bpd) to 690,000 bpd and also trimmed its forecast for 2009 global demand growth by 40,000 bpd to 890,000 bpd.[ID:nLA109634]

This is confirmed by Saudi production rising to 9.6 million bpd in last month’s report.

OPEC’s decision to stick to quotas gives the Saudis cover should demand for their output fall and be seen as a production cut by the rest of the world.

Oil prices had gained a dollar earlier Wednesday after OPEC ministers meeting in Vienna made the unexpected decision to cut output by around 500,000 barrels per day (bpd) from the market after high fuel prices and wider economic problems hit demand in the United States and other large consumer nations.

Any pickup in the US or Euro economies will probably increase demand for crude, and the Saudis don’t have more than maybe 1 million bpd spare capacity.

The ‘Master’s sell-off’ may have run its course, allowing the Saudis to work prices higher if they so desire.

Lower crude prices continue to support the USD.

*U.S. crude inventories down after Gustav

*OPEC makes unexpected output cut

*IEA cuts 2008, 2009 global demand forecasts

*Hurricane Ike likely to miss offshore oil, refineries

NEW YORK, Sept 10 (Reuters) – U.S. crude oil futures fell more than a dollar in volatile trading on Wednesday as a government report showed crude oil supplies building up in the nation’s primary Gulf Coast refining region after Hurricane Gustav crippled several plants last week.

The increase in crude inventories in the Gulf Coast region offset concerns over a larger-than-expected nationwide drawdown, dealers said.

NYMEX October WTI futures CLV8 CLc1 were down $1.53 at $101.73 a barrel, at 11:01 a.m. EDT (1501 GMT), trading between $101.36 and $104.97 a barrel.

“One reason that crude is selling off in the face of a seemingly supportive 5.9 million barrel (nationwide) crude draw is the fact that stocks actually built by 1.8 million barrels in the Gulf Coast region as crude supply was backed away from the downed refineries,” said Jim Ritterbusch, president, Ritterbusch & Associates, Galena, Illinois.

Weekly data from the U.S. Energy Information Administration showed refinery utilization plunged to 78.3 percent of total capacity in the week ending Sept. 5, the lowest level seen since October 2005 when hurricanes Katrina and Rita ravaged Gulf Coast refineries.

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(an email exchange)

>   
>   On Thu, Aug 7, 2008 at 7:15 AM, Scott wrote:
>   
>   crude moves further in backwardation.
>   

Right, indicating futures buying subsiding and inventories not above desired levels for commerce.

>   
>   CL vs brent now 160 over vs 120 under 2 weeks ago!
>   

Also indicating any excess inventory is gone, thanks!

Might be near the end of the second Master’s sell off.

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(an email exchange)

>   
>   
>   On Wed, Aug 6, 2008 at 12:25 AM, Prof. P. Arestis wrote:
>   
>   Dear Warren,
>   
>   Just received the piece below. The situation over here is getting
>   worse but pretty much as expected.
>   
>   Recession signalled by key indicators of British economy
>   
>   
>   Best wishes, Philip
>   

Dear Philip,

Yes, seems tight fiscal has finally taken its toll and is now reversing the ugly way – falling revenues and rising transfer payments.

Without support from government deficit spending, consumer debt increases sufficient to support modest growth are unsustainable.

And with a foreign monopolist setting crude oil prices ‘inflation’ will persist until there is a large enough supply response,

It’s the BoE’s choice which to respond to, though ironically changing interest rates is for the most part ceremonial.

All the best,
Warren

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(an email)

>   
>   W
>   you can tell everyone it is vitol but don’t give the source.
>   looks like traditional speculation; not the masters index speculation.
>   
>   

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[Skip to the end]

>   
>   On 8/3/08, Craig wrote:
>   
>   Ok. And the irony is as prices fall, demand increases again.
>   Until consuming governments get their head around that fact
>   and put some kind of floor under crude prices to incent
>   substitution (which may be beyond their thinking and/or impossible
>   politically), it seems like crude prices are gonna play rope-a-dope
>   with consumers.
>   
>   
>   Craig
>   
>   

Crude will be rationed as is everything else (scarcity, etc.).

The question is how. Ration by price or by other things?

Rationing by price is the most pervasive and means the wealthy (by definition) outbid the less wealthy for the available supply.

Make you wonder why the Democrats support higher prices, as that means they support their supporters going without while the wealthy drive any size SUV they want. Much like wondering why Obama supports Bernanke after Bernanke explained to Congress how he’s keeping inflation down by keeping a lid on inflation expectations after explaining the main component of inflation expectations is workers demanding higher wages, meaning Obama, Kennedy, and the rest of the left is praising Bernanke for doing a good job of suppressing wages.

Non-price rationing is less common but not unfamiliar, such as mandating cars get an average of 27 mpg, minimum efficiency standards for refrigerators, windows, etc. This takes an element of rationing by price away and results in the wealthy consuming less and leaving some for the less wealthy to consume a bit.

So seems to me the logical path for the Democrats would be something like my 30 mph speed limit for private transportation, which is ‘progressive’ and also drives the move towards public transportation with non price incentives as previously outlined. But there hasn’t even been any discussion of a progressive policy response. All seem highly regressive to me.

So I expect the world’s new and growing class of wealthy will continue to outbid our least wealthy for fuel and other resources.

Also, there may be limits to how high we want world consumption/burning of fuels for all the various ‘green’ reasons.

That would mean drilling and other production increases are out, as would be increased use of coal via the electric grid for electric cars.

And, again, it would be the world’s wealthy outbidding the less wealthy for consumption of the allowable annual fuel burn, as somehow allocation by price continues to rule.

Most paths keep coming down to the continuing combination of weakness and higher prices.

Warren

[top][end]

(comments from my brother, Seth, who was cc’d)

>   
>   I think democrats have lots of business and profits waiting
>   in govt subsidies for wind and solar. If oil prices fall that goes
>   away for now and they can’t produce on the subsidies for
>   them-cynical view but probably true
>   
>   There are also a lot of wealthy democrats and they want their
>   votes. Poor people all vote for democrats anyway-even with
>   declining lifestyles they are not going to McCain. So I think
>   Obama is pandering to the wealthy-it might be who he is-no
>   one really knows.
>   
>   With all of their green talk I have not seen any of them reduce
>   air travel, suv caravans or turn off the a/c in the capital. Just a
>   way to get votes and sound concerned. I saw a tv program
>   about how the chinese olympic swimming building is a green
>   sustainable building. It is 7 acres, pools, 25,000 people.
>   they finally said it uses about 25% less energy than a comparable
>   building would have. That is not green or sustainable, especially
>   since the building was not needed in the first place. I think “green”
>   is about making money, not the environment.
>   
>   
>   Seth
>   

I just can’t allow myself to be that cynical like you new yorkers!

:)

Warren

>   
>   
>   I think I am cynical usually, but this green thing drives me nuts
>   it started 30 years ago but is now all about money
>   when I see some lights turned off in Times Square (even in the
>   daytime) or the 5 huge spot lights on the CBS building lighting up
>   Katie Couric’s 50′ x 30′ poster which are on 24 hours a day turned
>   off, then I will believe it is about resources and not money.
>   there is a long way to go.
>   they advertise expensive green buildings here-I am not kidding-the
>   big thing is thermostats with timers on them and bamboo floors-didn’t
>   we have those 30 years ago??
>   
>   they talked about the oscar ceremony being green this year-the
>   celebrities were all giddy about it-what they did was use red
>   carpet made of recycled fibers????? what is that?
>   absolutely nothing-
>   anyway, time to calm down. too much excitement here
>   seth -
>   
>   

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Just saw that the house just rejected this.

Looks like it was one more reason for technical weakness in crude, along with the vote to limit speculation and the oil storage company’s futures and cash market issues and bankruptcy.

White House threatens veto on bill to sell govt oil

by Tabassum Zakaria

(Reuters) The White House on Thursday threatened to veto legislation that would require the government to sell 10 percent of the oil in the nation’s emergency petroleum stockpile.

The House of Representatives was expected to vote on the bill later on Thursday. Democrats hope the legislation will lower oil prices by putting on the market more of the Strategic Petroleum Reserve’s light, sweet crude that is sought by refiners.

“Drawing down our emergency oil reserve in the absence of a severe energy disruption is counter to the purpose of the SPR, and offers the nation a quick fix instead of much needed long-term, responsible energy solutions,” the White House said in a statement.

The bill would require the government to sell 10 percent of the emergency stockpile’s oil, or 70 million barrels, in the open market. About 40 percent of the stockpile’s oil is light sweet crude.

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(an email exchange)

>   
>   On Sun, Jul 20, 2008 at 10:46 PM, Russell wrote:
>   
>   Brad Setser, at Follow the Money, presents a couple of graphs on changes in
>   oil export revenue: The Oil Shock of 2008.
>   
>   The following graph shows the Year-over-year change in oil exports as a
>   percent of world GDP (and in billions of dollars).
>   
>   

>   
>   Year-over-year change in oil exports
>   
>   This calculation assumes that the oil exporters will export about 45 million
>   barrels a day of oil.
>   
>   Each $5 increase in the average price of oil increases the oil exporters’
>   revenues by about $80 billion, so if oil ends up averaging $125 a barrel this year
>   rather than $120 a barrel, the increase in the oil exporters revenues would be
>   close to a trillion dollars.
>   
>   Assuming oil prices average $120 per barrel for 2008, the increase in 2008 will
>   be similar to the oil shocks of the ’70s.
>   
>   

Right, the notion that oil is a smaller % of GDP and therefore not as inflationary was flawed to begin with and now moot.

Two more thoughts for today:

First, the second Mike Masters sell-off may have run its course. The first was after his testimony in regard to passive commodity strategies which I agree probably serve no public purpose whatsoever. The second was last week as markets expect Congress to act to curb speculation this week, which they might. Crude isn’t a competitive market (Saudi’s are the swing producer) so prices won’t be altered apart from knee jerk reactions, but competitive markets such as gold can see lower relative prices if the major funds back off their passive commodity strategies.

Second, just saw a headline on Bloomberg that inflation is starting to hurt the value of some currencies.

Third, the Stern statement will continue to weigh on interest rate expectations up to the Aug 9 meeting.

[Skip to the end]

Seems like a sale ahead of possible Congressional action to limit ’speculation’.

Not sure how big the dip might be, but yet another buying op as the choice remains – pay the Saudis their asking price or shut the lights off.

The price only goes down if the Saudis cut price, or if there is a supply response of more than 5 million bpd that dislodges them from being swing producer.

[top]

[Skip to the end]

This is the deflation argument.
(See below)

Never seen a split quite like this with calls for both accelerating inflation and outright deflation.

Which will it be?

My guess is inflation for the US as our friendly external monopolist continues to squeeze us with ever higher crude prices.

The political process is ensuring they will be passed through as sufficient government ‘check writing’ (net government spending) is sustained to support real growth.

(Bear Stearns, housing agencies, fiscal rebates, fiscal housing package, etc.)

And the dollar continues to adjust to the sudden, politically induced shift in foreign desires to accumulate USD financial and domestic assets.

Various private Q2 GDP estimates are now up to 2% – more than sufficient to support demand and pass through the higher headline prices.

Government is never revenue constrained regarding spending and/or lending.

The limit to government check writing is the political tolerance for inflation, which grows with economic weakness.

This inflation looks to me to be far worse than the 1970s.

Back then, we were able to muster a 15 million bpd positive supply response in crude that broke OPEC by deregulating natural gas.

We don’t have that card to play this time around.

From HFE:

July 14, 2008

WORLDWIDE:

• Global Disinflation Is Going To Be The Next Big Move For The Bond Markets – Weinberg
• Commodity And Oil Prices Cannot Rise Forever… There Is No Inflation – Weinberg
• Bonds To Benefit – Weinberg

UNITED STATES:

• STOP PRESS: Treasury, Fed To Make Credit Available To GSEs; Treasury To Seek Authority To Buy Their Stocks – Shepherdson
• This Is A Lifeboat, Not a Bailout; Aim Is To Prevent Uncontained Failure – Shepherdson

CANADA:

• We Cannot Rule Out A Rate Cut Tomorrow – Weinberg

EURO ZONE:

• Core CPI Shows No Medium-Term Inflation Risks – Weinberg
• Production Data Will Be Really Soft – Weinberg

GERMANY:

• Core CPI Still Under 2% And Steady, ZEW At New Record Low – Weinberg
• … Tighter Money Is Unhelpful Here – Weinberg

UNITED KINGDOM:

• Starting Point For August QIR Forecasts To Emerge In This Week’s
• Reports: Most Inputs To The Forecasts Will Be Stronger – Weinberg

FRANCE:

• Not-Too-Scary Inflation Report Exported: Core Prices Are Steady – Weinberg

JAPAN:

• Three Soft Report This Week Will Keep Investors Moving Out Of Stocks, Into Bonds – Weinberg

AUSTRALIA:

• CPI Report For Q2, Due Next Week, May Rekindle Inflation Worries – Weinberg

CHINA:

• Exploding Foreign Borrowing Diminishes Foreign Currency Reserve Adequacy; Trends Suggest Further Decay – Weinberg
• GDP Will Be Below Recent Trend In This Week’s Report – Weinberg

[top]

Bank deputy chief warns of market trouble to come

by Ben Russell, Political Correspondent and Sean O’Grady

Britain is facing the risk of renewed turmoil in the financial markets, the new deputy governor of the Bank of England warned yesterday.

Professor Charlie Bean, the deputy governor for monetary policy and a former chief economist at the Bank, raised the prospect of a slowing global economy triggering a new round of problems with corporate loans and said that the impact of the credit squeeze could be greater than Bank projections.

Yes, but unlike the Eurozone, the BoE is permitted to ‘write the check’ as in the treasury.

National solvency is not an issue in the UK as it is in the Eurozone when weakness is addressed.

He told members of the Commons Treasury Select Committee that Britain faced “major conflicting risks” threatening the Government’s inflation target from the problems of a slowing economy and rising commodity prices.

Yes, the twin themes of weakness and inflation.

In a memorandum to the committee, Professor Bean warned that the “dislocation” in the financial markets “probably has further to run, especially if a slowing economy here and abroad generates a second round of write-downs, this time associated with corporate loans. Moreover, the impact of the tightening in the terms of availability of credit could prove greater than is embodied in the central case in our most recent set of projections”.

Agreed. And while ‘writing the check’ can readily address these issues with no risk to government solvency, it will also support the higher prices he next discusses:

He said that increasing oil and other commodity price rises would lead to higher inflation becoming “embedded in the economy”, warning that people might seek to offset price increases by making higher wage demands. He said: “There is no doubt that the UK economy presently faces the most challenging set of circumstances since at least the early 1990s and probably earlier.”

Professor Bean said oil prices could continue to rise for another two years and cautioned that Britain faced the danger of a pay-price spiral if workers tried to compensate by pushing up wages. He said: “It certainly poses a significant challenge. There is no doubt about that at all. It may be a relatively unlikely event but it could be particularly unfortunate if it happened, if households and businesses start losing faith in the idea that inflation will stay low, round about the target, they start building it into their pay and prices and inflation becomes much more embedded into the system… Provided pay growth remains subdued, the current pick-up in inflation will be temporary.”

Living standards, the deputy governor stressed, will inevitably be lower because of the global inflation in commodity prices.

Agreed. It’s all about real terms of trade, which have also been declining rapidly in the US as evidenced by the drop in growth of GDP and the drop in non-oil trade deficit.

My guess is the most likely political response in the US and the UK is proactive deficit spending from the treasury to address the weakness and higher interest rates to address the inflation.

Unfortunately the deficit spending that supports domestic demand will also support crude consumption (as well as housing) and ‘monetize’ the ever higher crude prices being set by the Saudis, thereby supporting ‘inflation’ in general.

And this will trigger ever higher interest rates from the Central Bank as inflation trends even higher.

[Skip to the end]

Saudi Arabia Not Willing to See Crude at Discount, Naimi Says

by Fred Pals
(Bloomberg) Saudi Arabia, the world’s largest oil exporter, is not willing to sell crude oil at a discount to the normal market price for its grades of oil, the kingdom’s oil minister said.

The country plans to increase production for a third straight month this month. Analysts including the London-based Centre for Global Energy Studies have said Saudi Arabia may need to lower its prices to find sufficient buyers.

“No,” Oil Minister Ali al-Naimi said when asked about his willingness to sell crude at a discount. “Not even for heavy crude. That is not the way the market works. We have said we don’t like high prices. We have nothing to do with where the price is today. Where is the buyer? We would be very happy to sell.”

Al-Naimi spoke to reporters today at the World Petroleum Congress in Madrid.

Right, you can have all you want at their price.

Simple monopoly.

Good luck to us – we don’t even know it’s happening.

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(an email exchange)

A few of things:

First, the rising wages in the 70’s led to bracket creep that put the budget in surplus in 1979 and resulted in a severe recession soon after.

This time around it is unlikely the inflation takes much of a dent out of the deficit so it’s more likely demand will be sustained to support prices. And, at least so far, Congress has acted to sustain demand and support prices with the latest fiscal package and more seemingly on the way.

Second, last time around the oil producers for the most part didn’t spend all that much of their new found revenues and thereby drained demand from the US economy. This time around they seem to be spending on infrastructure at a rate sufficient to drive our exports and keep gdp muddling through.

Third, I recall it was maybe the deregulation of nat gas that freed up a cheap substitute for electric utilities and unleashed a massive supply response as nat gas was substituted for crude at the elect power producers. After 1980 opec cut production by something like 15 million bpd to hold prices above 30 until they could cut no more without capping all their wells and the price tumbled to about 10 where it stood for a long time. This time around that kind of excess supply is nowhere in sight.

>
>   On Thu, Jun 12, 2008 at 11:59 PM, Russell wrote:
>
>   Stephan Roach is chairman of Morgan Stanley Asia, and pens
>   this missive for the FT, in which he contextualizes why the
>   Fed’s options are limited:
>
>   ”Fears of 1970s-style stagflation are back in the air. Global
>   bond markets are growing ever more nervous over this possibility,
>   and US and European central bankers are talking increasingly
>   tough about the perils of mounting inflation.
>
>   Yet today’s stagflation risks are very different from those that
>   wreaked such havoc 35 years ago. Unlike in that earlier period,
>   wages in the developed economies have been delinked from prices.
>   That all but eliminates the automatic indexation features of the
>   once dreaded wage-price spiral – perhaps the most insidious
>   feature of the “great inflation” of the 1970s. Moreover, as the
>   stunning surge of the US unemployment rate in May suggests,
>   slowing economic growth in the industrial economies is likely to
>   open up further slack in labour markets, thereby putting downward
>   cyclical pressure on wages over the next couple of years.
>
>   But there is a new threat to global inflation that was not present
>   in the 1970s. It is arising from the developing world, especially in
>   Asia, where price pressures are lurching out of control. For
>   developing Asia as a whole, consumer price index inflation hit 7.5
>   per cent in April 2008, close to a 9½-year high and more than double
>   the 3.6 per cent pace of a year ago. Sure, a good portion of the recent
>   acceleration in pricing is a result of food and energy – critically
>   important components of household budgets in poorer countries and
>   yet items that many analysts mistakenly remove to get a cleaner read
>   on underlying inflation. But even the residual, or “core”, inflation rate
>   in developing Asia surged to 3.8 per cent in April, more than double
>   the 1.8 per cent pace of a year ago…”
>
>

[top]

(an interoffice email)

>
>   On Wed, Apr 9, 2008 at 4:05 PM, Pat wrote:
>
>   What about the continued allocation increases from non-end
>   users of commodities? From what I’ve read allocations by
>   pensions have gone higher even with the rising prices as well
>   as a whole host of new entrants (ETFs, HF’s, etc…) Are these
>   compounding the problem or are they the root of the
>   commodity price inflation?
>
>

passive commodities are part of the landscape for sure:

1. put upward pressure on competitive commodity spot prices
2. put downward pressure on the $
3. add to gdp
4. in general, help ‘monetize’ saudi crude price hikes
5. put upward pressure on crude futures
6. serves no public purpose

Saudi Oil Production

Even with crude prices now well over $100 there’s no sign of demand for Saudi crude falling off. I expect they will continue to act as swing producer, setting price and letting quantity adjust, until a large enough supply response forces their production down below 7 million bpd.

Supplies probably aren’t ‘excessive’ or US companies wouldn’t import so much and futures spreads would be in contango instead of backwardation, and WTI now trading above Brent is another sign inventories are back towards the tight side.

Oil Falls Below $98 on Swelling US Crude Supplies

Oil held steady around $98 a barrel on Friday, off its recent record above $101 as rising U.S. crude and gasoline stockpiles added to evidence of slowing demand in the world’s largest consumer.

(an email)

> On Feb 19, 2008 10:03 AM, Mike wrote:

> Warren, note spec comments and dollar issues, a big hurdle to overcome
> if they go the other way …
> Mike

Hi Mike,

Agreed the dollar may have bottomed. Seems to have reached a level where exports are now growing at about 13% which maybe is the right number to accommodate the pressure from the non resident sector to slow it’s accumulation of $US financial assets.
However I continue to conclude the price of crude is being set by the Saudi’s/Russians acting as swing producer, and that there is sufficient demand to keep them in the driver’s seat. Quantity pumped keeps creeping up at current prices, with Saudis last reporting 9.2 million bpd output.

Crude at 98.70 now. Note crude goes up on news a refinery is down, when refineries are the only buyers of crude, so in fact it’s going up for other reasons (price setting by the swing producer?). Also, WTI is now ahead of Brent, indicating whatever was causing the sag in WTI vs Brent is over. WTI would ordinarily trade higher than Brent due to shipping charges.

Warren

Higher oil prices mean lower rates from the Fed, and higher inflation rates induced by shortages mean stronger currencies abroad.

Why do I have so much trouble getting aboard this paradigm, and instead keep looking for reversals? Feels a lot like watching the NASDAQ go from 3500 to 5000 a few years ago.

:(

Calories, Capital, Climate Spur Asian Anxiety

2007-12-26 17:51 (New York)
by Andy Mukherjee

(Bloomberg) — The new year may be a challenging one for Asian policy makers.

Year-end U.S. closing stocks for wheat are the lowest in six decades; soybeans in Chicago touched a 34-year peak this week. Palm oil in Malaysia climbed to a record yesterday.

The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc. economist in Hong Kong. Growing use of food crops in biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.

The wholesale price of pork in China has surged 53 percent in the past year.

“Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows,” Subbaraman says.

If the U.S. Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.

Food and energy account for more than two-fifths of the Chinese consumer-price index, compared with 17 percent for countries such as the U.K., U.S. and Canada, and 25 percent in the euro area, according to UBS AG economist Paul Donovan in London.

As Asian central banks raise interest rates — when the Fed is cutting them — they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region’s exports.

Carbon Emissions

On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.

That isn’t all.

Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast-growing Asian nations such as China and India.

As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal — relative to crude oil — has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.

This doesn’t augur well for the environment.

“Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more intensive in carbon than it would otherwise be,” Gros said.

Beijing Olympics

Climate-related issues will be in the spotlight in Asia next year. China’s eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges will be one of the “big things to watch for” in Asia in 2008, Spire Research and Consulting, a Singapore-based advisory firm, said last week.

Even if China succeeds in reducing air pollution during the Olympics, the improvements may not endure after the sporting event ends on Aug. 24, especially since the underlying economics continue to favor higher coal usage.

A drop in hydrocarbon prices might help check emissions and global warming, Gros noted last week on the Web site of VoxEu.org.

In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.

That will leave capital flows as Asia’s No. 1 challenge in 2008. And it won’t be an easy one for policy makers to tackle.

Capital Inflows

Take India’s example.

The $900 billion economy has attracted $100 billion in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.

This has caused the rupee to appreciate more than 12 percent against the dollar this year, knocking off more than three percentage points from India’s inflation index, says Lombard Street Research economist Maya Bhandari in London.

Naturally, exporters are complaining.

So why doesn’t India cut domestic interest rates? It can’t do that without the risk of stoking inflation.

Money supply is growing at an annual pace of more than 21 percent in India, compared with the central bank’s target of between 17 percent and 17.5 percent. Inflation has held well below the central bank’s estimate of 5 percent for five straight months partly because of the government’s insistence on not passing the full cost of imported fuel to local consumers. It isn’t yet time for monetary easing in India.

China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan — the root cause of its record trade surpluses and the attendant liquidity glut — until the Olympics are out of the way.

Asian economies may, to a large extent, be insulated from the subprime mess. Still, 2008 won’t be all fun and games.

(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)

–Editors: James Greiff, Ron Rhodes.

To contact the writer of this column:
Andy Mukherjee in Singapore at +65-6212-1591 or
amukherjee@bloomberg.net

To contact the editor responsible for this column:
James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net

CNBC just had a session on trying to reconcile high gdp with large credit losses. Seems they are now seeing the consumer clipping along at a +2.8% pace for Q4. No need to rehash my ongoing position that most if not all the losses announced in the last 6 months would have little or no effect on aggregate demand. Credit losses hurt demand when the result is a drop in spending. And yes, that happened big time when the subprime crisis took the bid away from would be subprime buyers who no longer qualified to buy a house. That probably took 1% away from gdp, and the subsequent increase in
exports kept gdp pretty much where it was. But that story has been behind us for over a year.

The Fed is not in a good place. They should now know that the TAF operation should have been done in August to keep libor priced where they wanted it. They should know by now losses per se don’t alter aggregate demand, but only rearrange financial assets. The should know the fall off in subprime buyers was offset by exports.

The problem was the FOMC- as demonstrated by their speeches and actions- did not have an adequate working understanding of monetary operations and reserve accounting back in August, and by limiting the current TAFs to $20 billion it seems they still don’t even understand that it’s about price, and not quantity. Too many members of the FOMC
are mostly likely in a fixed exchange rate paradigm, with its fix exchange rate/gold standard fractional reserve banking system that drove us into the great depression. With fixed exchange rates it’s a ‘loanable funds’ world. Banks are ‘reserve constrained.’ Reserves and consequently ‘money supply’ are issues. Government solvency is an issue.

With today’s floating exchange rate regime none of that is applicable. The causation is ‘loans create deposits AND reserves,’ and bank capital is endogenous. There are no ‘imbalances’ as all current conditions are ‘priced’ in the fx market, including ANY sized trade gap, budget deficit, or rate of inflation.

The recession risk today is from a lack of effective demand. There are lots of ways this can happen- sudden drop in govt spending, sudden tax increase, consumers change ’savings desires’ and cut back spending, sudden drop in exports, etc.- and in any case the govt can instantly fill in the gap with net spending to sustain demand at any level it desires. Yes, there will be inflation consequences, distribution consequences, but no govt. solvency consequences.

So yes, there is always the possibility of a recession. And domestic demand (without exports) has been moderating as the falling govt budget acts to reduce aggregate demand. But the rearranging of financial assets in this ‘great repricing of risk’ doesn’t necessarily reduce aggregate demand.

Meanwhile, the Saudis, as swing producer, keep raising the price of crude, and so far with no fall off in the demand for their crude at current prices, so they are incented to keep right on hiking. And they may even recognize that by spending their new found revenues on real goods and services (note the new mid east infrastructure projects in progress) they keep the world economy afloat and can keep hiking prices indefinitely.

And food is linked to fuel via biofuels, and as we continue to burn up every larger chunks of our food supply for fuel prices will keep rising.

The $US is probably stable to firm at current levels vs the non commodity currencies, as portfolio shifts have run their course, and these shifts have driven the $ down to levels where there are ‘real buyers’ as evidenced by rapidly growing exports.

Back to the Fed – they have cut 100 bp into the triple negative supply shock of food, crude, and the $/imported prices, due to blind fear of ‘market functioning’ that turned out to need nothing more than an open market operation with expanded acceptable bank collateral (the TAF program). If they had done that immediately (they had more than one outsider and insider recommend it) and fed funds/libor spreads and other ‘financial conditions’ moderated, would they have cut?

There has been no sign of ’spillover’ into gdp from the great repricing of risk, food and crude have driven their various inflation measures to very uncomfortable levels,and they now believe they have ‘cooked in’ 100 bp of inflationary easing into the economy that works with about a one year lag.

Merry Christmas!

This means Saudis/Russians will continue to be price setters for at least the next few quarters.

IEA Lifts 2008 World Oil Demand Growth Forecast

By Reuters | 14 Dec 2007 | 05:32 AM ET

World oil demand will grow more quickly than expected next year fueled by the Middle East and proving resilient to record-high prices, the International Energy Agency said on Friday.

The IEA, adviser to 27 industrialized countries, said in its monthly Oil Market Report that demand will rise by 2.1 million barrels per day (bpd) next year, up 200,000 bpd from its previous forecast.

“A lot of this demand is in the non-OECD countries, where we don’t have any downgrades in economic growth forecasts,” said Lawrence Eagles, head of the IEA’s Oil Industry and Markets division.